Oil stock investors hit a gusher; can it last?

It has been almost impossible not to make money over the past several months owning energy stocks. The numbers remain stunning and, for many investors, enticing.

The American Stock Exchange Oil and Natural Gas index is up about 46 percent since the beginning of 2005. Over that same time, the Standard & Poor's 500 index has risen 6 percent.

Much of the run-up in oil stocks has been driven by a more than 35 percent increase in the price of a barrel of crude over the past 12 months. But higher crude prices do not necessarily translate into higher prices for energy stocks, said Phil Dodge, energy research analyst at the Stanford Group.

As for large "integrateds" such as Exxon Mobil Corp., their stocks have been quite volatile, because higher crude prices also mean higher costs for their refining, marketing and chemical operations.

Given the overall run-up in energy stocks, some observers are wondering whether the sector is overvalued.

When energy companies report first-quarter earnings this month, their numbers are likely to make owning oil stocks seem like a license to print cash.

Merrill Lynch is forecasting that earnings at oil services and drilling companies for the first quarter will have risen 11 percent over the fourth quarter and a whopping 79 percent over the same period in 2005.

"Anyone who doesn't show an earnings increase in the first quarter must have something badly wrong going on," Dodge said.

But for those contemplating a jump into energy stocks, Rick Drake, Chicago-based co-manager of the $1.1 billion ABN Amro Growth Fund, urges investors not to bite.

Drake argues that crude prices are being kept artificially high by investors using fears of political unrest in Iran, Nigeria or Venezuela to speculate on oil futures. Last week, crude topped $69 a barrel on fears of military action against Iran, pushing prices near the intraday record $70.85 a barrel hit shortly after Hurricane Katrina slammed into the Gulf Coast.

Energy stocks, Drake said, have begun to emulate tech stocks in 1999. Just because China and India are consuming more oil, he said, investors assume demand will forever outpace supply by tenfold.

But worldwide production has significantly boosted inventories over the past six months, he said. At the same time, large U.S. gasoline providers such as Exxon Mobil are under pressure from Congress to use their profits to drill for oil rather than buy back company shares.

"I think oil is hyped," Drake said. "There's a lot of speculation going on right now in oil futures, and that's forced commodity prices higher, and that's led to investors pushing equity prices higher as a result."

But recent stock gains, counters Fadel Gheit, energy analyst at Oppenheimer & Co., have had as much to do with company fundamentals. Gheit said oil and gas stocks are undervalued, pointing to cash flows.

Of the 24 oil and gas companies Gheit covers, which account for more than 80 percent of industry revenues, operating cash flow last year hit $201 billion, up 26 percent from 2004.

Energy companies, he said, are spending on production in anticipation that world demand will grow 1.5 percent to 2 percent a year for the next 10 years.

Gheit rates all of the stocks he covers a "buy," though he particularly likes ConocoPhillips, especially after its $35.6 billion cash and stock acquisition of natural gas exploration and production firm Burlington Resources Inc. While an economic slowdown could push crude below $55 a barrel, Gheit said, output disruptions anywhere in the world just as easily could push crude over $70 a barrel.

The question of political unrest hangs over oil. Gil Knight, senior portfolio manager at Gartmore Global Investments in Conshohocken, Pa., said such uncertainties may be adding as much as $5 to $10 a barrel to crude prices.

Knight said worldwide inventories have been on the rise and, therefore, crude prices should be coming down. But oil is an unusual commodity.

"Every time we see the price of oil go back down, something pushes it up again," said Knight, who manages about $500 million across a group of Gartmore funds. "If crude stays up this high into the third quarter, these stocks will have shown they have a lot more in them."

Knight has nearly 10 percent of his portfolio in energy stocks. He prefers drilling and exploration companies, citing long-term world demand. Stanford Group's Dodge agrees, naming Noble Corp., an offshore driller, and Cooper Cameron Corp., an equipment and services provider, among his favorites.